John Wilson, a senior portfolio manager with Sprott Asset Management, said recently that investors tend to get more comfortable with equity markets when equity markets are riding high versus when equity markets are riding low. What are your thoughts?
Adrian Day: That’s true; you see that in the broad market and in the gold market. The broad market has been a pretty steady move up from the middle of November until now, and yet all the way through the beginning of January the public was still very heavy sellers, not buyers, of equities. Then they started buying in January.
If you look at the gold stocks, you need to be very discriminating about what you buy. A lot of the senior companies have had management shakeups because of bad acquisitions or overpriced acquisitions, capital expenditure (capex) overruns and bad capital allocation decisions; a lot of decisions were made in the last few years simply for the sake of getting bigger. For a few years, the market was indiscriminate, and everything was going up. But for the last six months, the market generally has been a lot more discriminating. Stocks of companies that have good balance sheets and inexpensive or very good projects and are advancing them nicely are doing reasonably well despite the overall negativity in the sector. Some amazing companies are selling at very good prices, and yet nobody seems interested right now.
TGR: Is your gold portfolio mostly equities? Do you dabble in exchange-traded funds (ETFs)?
AD: We buy physical bullion and ETFs. We have been known to buy bonds, although we’re not buying any bonds at the moment. The portfolio is primarily equities.
TGR: You allocate a portion of your clients’ portfolios to juniors, but you also have significant positions in larger-cap gold equities. John Paulson said in late March that he believes that gold companies need to get smaller and spin out some of their mines into other companies and operate on a much smaller scale. Do you think that’s realistic, and do you think that that’s a sound approach to generating shareholder value?
AD: I would flip it around and say that companies need to stop fixating on getting bigger simply for the sake of getting bigger. That doesn’t necessarily mean that companies have to get smaller, but certainly a smaller profitable company is a better company than a larger unprofitable company.
The model has changed a lot in the last 30 years. In the 1960s and 1970s, the biggest mines and the biggest companies in the world were the South African ones, and generally they were single-mine companies. Some mines had relatively short lives; other mines had multidecade lives. The companies would generate revenue and pay that revenue out as dividends to shareholders, hence the dividends were high. Over the years the model changed from being single-mine companies to ongoing enterprises. The problem with the ongoing enterprise model is that it is extremely difficult to find 5–7 million ounces (5–7 Moz) gold per year, so you end up buying it. No company wants to shrink, so if you’re producing 7 Moz, you better find 7 Moz. If that means buying it, so be it. If it means overpaying, that’s the price you pay to keep growing. That is a mistake.